Why China keeps increasing US debt holdings

By Yi Xianrong (Beijing Times)

17:02, August 19, 2011

Edited and Translated by People's Daily Online 

Investors snapped up 24 billion U.S. dollars worth of 10-year notes issued by the U.S. Treasury at a record-low yield of slightly more than 2 percent on Aug. 10. According to statistics released by the U.S. Treasury on Aug. 15, China purchased another 5.7 billion U.S. dollars worth of Treasury bonds in June, increasing its total U.S. debt holdings to nearly 1.2 trillion U.S. dollars, which remain the largest in the world. This was the third consecutive monthly increase by China since April. The country increased its holdings of U.S. debt by 20.6 billion U.S. dollars from early April to late June. 

Due to the downgrade of the U.S. credit rating by Standard & Poor's, the prices of various assets have dropped sharply worldwide over the past two weeks, and global stock markets have also suffered severe declines. However, the prices of gold and U.S. bonds have risen against the global downward trend. 

The downgrade of the U.S. credit rating was meant to warn investors of the high risk of U.S. debt, and the United States was supposed to raise yields in order to sell its bonds. Then why are the market reactions so counterintuitive?

Generally speaking, when the entire world is facing serious financial risks, investors will attach much greater importance to the safety of their assets than to investment returns. More specifically, their top priority will be to safeguard, not to increase, the value of their assets. Hoarding gold can certainly minimize risks, but the amount of gold in the world is limited compared to the massive funds that need a safe haven. In fact, physical commodities, including gold, oil and bulk commodities have only a limited capacity to absorb funds. They have been financialized and become almost the same as general financial assets in nature, so it is also highly risky to hold these assets. 

Therefore, when it is possible that a global or local financial crisis will break out, the fast-flowing "hot money" of between 16 trillion and 17 trillion U.S. dollars will flow to the strongest currencies or national debts. The most important standards used for measuring the currency of a country include the country's national strengths — education, science, technology and political system — and the internationalization level of the currency. If we measure currencies using these standards, the U.S. dollar is obviously the strongest. 

Although the U.S. dollar keeps depreciating, it is still unmatchable compared to currencies of any other countries. In addition, the reason for U.S. dollar depreciation is only that the United States is trying to solve its domestic economic problem by using its dominance in international currency. Therefore, compared to other financial assets, U.S. treasury securities are less risky, and when certain financial risk appears in the world, the fast-flowing assets will flow to the U.S. national debt to resist the risk. That's why the higher the global market risk is, the more assets will flow to the U.S. national debt. 

In this situation, if China does not hold U.S. treasury securities for its foreign reserve, what else can China hold? Therefore, although China was unwilling to do it, China has continued to buy U.S. treasury securities for three successive months. That’s why China recently decreased its Japanese treasury securities and increased its U.S. treasury securities. 

Recently, an unclear viewpoint is very popular in the market. It says that buying U.S. treasury securities means poor people lend money to rich people, and that is not fair. The U.S. economy has been gloomy for a long period, and that has brought a huge depreciation risk to the U.S. treasury securities held by China. Therefore, the U.S. Government must guarantee that the U.S. treasury securities held by China will not depreciate. 

Actually, individuals who do not know much about finance give these kinds of speeches. As a kind of investment activity, buying U.S. treasury securities has always been an independent choice of China. Since it is a kind of investment and the transaction is done in the market, both the creditor and debtor will get what they want. It is not the so-called unfair thing of poor people lending money to rich people. It is actually like depositing money in the bank, and furthermore, the interest rate of the securities is under control. Are our residents not willing to deposit their money in the bank rather than keep it at home? It is more rational to deposit the money in the bank than keep it at home. 

Some may say that, since the investment in U.S. national debts is faced with the risk of U.S. dollar devaluation, then instead of giving the money to civilians to improve their welfare standards, why is the investment still made into U.S. national debts? It is certain that using the foreign exchange reserve to buy physical commodities in the international market, which would be distributed to citizens, could improve civilians‘ welfare. But for such a giant country as China with such a large population, how to distribute? And what commodities should be bought? We actually intend to change money into commodities, but would the suddenly increased demands for commodities lead to soaring prices? Then would China not be a scapegoat? 

Actually, after sorting out these basic problems, we should be able to understand that investing in U.S. national debts is the best choice in the adverse situation when we hold a large quantity of foreign exchange reserves, or else the risks faced by China's foreign exchange reserves may be higher. This is the reason why China has been increasing its investment in U.S. national debts these past few months.

In order to fundamentally relieve China's current huge risks of overly high foreign exchange reserves and foreign exchange reserves' devaluation, China has to begin with reforms of its industrial structure, foreign trade policy and exchange rate policy to change China‘s unreasonable industrial structure and realize the balances of import and export trade and financial projects. 

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